NUA (Net Unrealized Appreciation) in Scenario Analysis

Normally, any distributions from a 401(k) are taxable as ordinary income. In certain cases, employees are allowed to move employer stock from a 401(k) into a taxable brokerage account when they leave that employer. The difference between the cost basis of the shares and the market price is referred to as Net Unrealized Appreciation (NUA). This NUA amount is not subject to income tax upon transfer.

Ideally, one can sell the shares after the NUA transfer and pay long-term capital gains rates, which are much lower than the rates on ordinary income. However, this doesn't mean the distribution of the employer stock is tax-free. The taxpayer still needs to pay income tax on the cost basis of the shares at the time of transfer, which users include in the projection.


How is this modeled in Scenario Analysis?

The NUA transaction consists of three distinct taxable items:

1. Cost Basis: Taxable as ordinary income on the transfer or distribution date.
2. NUA Gain:  Difference between cost basis and FMV on distribution date. Considered a long-term capital gain when shares are sold, regardless of holding period.
3. Post-Distribution Gain: Difference between FMV on distribution date and FMV on sale date. Subject to regular holding period rules relative to short or long-term capital gains tax treatment.

1) Cost Basis:

The cost basis of the shares is reported on Form 1099-R and will be taxed as ordinary income in the year of transfer. This is modeled in Holistiplan by entering that basis amount (and the amount reported on the 1099-R) in the IRA Distributions Worksheet.

Enter the basis of the shares in dollars into the Taxable IRA Distributions field for the appropriate taxpayer on the return, where the $9,750 figure appears outlined in blue below. Do not use the Override data entry box outlined in red, as the income needs to be taxpayer-specific.

 

2) NUA Gain:

The NUA gain is the difference between the basis in that stock and the fair market value of the company stock on of the date of distribution from the 401(k) plan. This NUA gain is considered a long-term capital gain when shares are sold and can be entered in the Capital Gains Worksheet, found in the Schedule D Income section.

3) Post-Distribution Gain:

This gain measures the difference in fair market value between the date of distribution and the eventual date of sale of the company stock. The post-distribution gain is taxed either as a short-term  or long-term capital gain, depending on the holding period. Like most capital gains, this holding period must be greater than one year to achieve long-term capital gains tax treatment.

NIIT Considerations:

In addition, the NUA gain portion (but NOT the post-distribution gain) is excluded from the 3.8% Net Investment Income Tax (NIIT). To reflect this, add these excluded gains on the line outlined below, within the Form 8960 area of the Other Taxes section in Scenario Analysis. More information on NUA and NIIT can be found in line 5b Instructions for Form 8960, linked here.